Monday, January 3, 2011

IMF warns Pakistan over budget hazards

IMF warns Pakistan over budget hazards 

KARACHI - A nine-month breather allowed to Pakistan by the International Monetary Fund (IMF) on meeting terms of a US$11 billion loan program came with a stern warning to the country to take steps to cut its spiraling budget deficit.

The IMF agreed to extend the term of the country's loan program, which was scheduled to end on December 31, by nine months through September to give Pakistan more time to take fiscal belt-tightening measures and to introduce a reformed general sales tax (RGST).

The reprieve is a rare bright note for President Asif Ali Zardari. On Sunday,  the Muttahida Qaumi Movement (MQM), the second-largest partner in the ruling coalition and the dominant political force in the port city of Karachi, said it planned to join the opposition benches in the National Assembly and senate in protest at government policies.
The government is facing strong opposition to introduce RGST, including from business interests in Karachi. The measure would broaden its tax base, while a shortfall in revenue and rising current expenditure have compelled it to borrow from the  central bank to meet its requirements, which in turn helps to drive up inflation. At present the country has the world's lowest tax-to-gross domestic product ratio in the world, at only 10%.

Pakistan promised the IMF it would introduce the new tax and make cuts in spending in return for the loan program in late 2008. The government's failures to follow up on its pledges mean that the revenue shortfall may drive up the fiscal deficit, which is already at 6% of gross domestic product, to above 7%, compared with the 4.7% target agreed with the IMF for fiscal year ending this coming June.
Some analysts argue that an unprecedented budget deficit and hyperinflation will follow if additional revenue is not generated.
Islamabad requested a nine-month extension from the IMF under its standby arrangement (SBA) with the Washington-based lender.

"The extension will provide time to the Pakistani authorities to complete the reform of the general sales tax, implement measures to correct the course of fiscal policy and amend the legislative framework for the financial sector," the IMF said in a recent statement.

The federal and provincial governments are split on how the change from the existing goods and services tax to RGST, which captures the features of a value added tax (VAT), should be implemented. The country missed the latest deadline of January 1 to introduce RGST, which was originally scheduled for July 1 last year. The IMF subsequently had withheld $3.5 billion from its agreed loan package for the country to pressure the government to take action.

The IMF has warned the government that the state of the nation's economy is far worse than previously realized and urged immediate fiscal belt-tightening measures, according to the Wall Street Journal.

The budget deficit will climb to an unprecedented 1.2 trillion rupees (US$14 billion) this fiscal year, the Business Recorder reported, citing economist Hafeez Pasha, a former member of the Economic Advisory Council.

Headline inflation rose to 15.48% in November, an 18-month high, on the back of high food prices, up from 15.33% in October.

"The rising fiscal deficit is squarely against one of the main covenants of the agreement with the IMF, which is likely to delay future tranches," Reuters reported Asad Iqbal, chief investment officer at Faysal Asset Management, as saying. "If the IMF loses confidence in the government's ability to manage this deficit, funding from other foreign institutions is also likely to dry up, resulting in severe consequences for the country.”

A block to foreign funding will shift the entire burden of budget financing on to the domestic market with the government left with no option but to borrow over 1 trillion rupees there, which will result in high inflation.

The government's borrowing for budgetary support from the central bank jumped by 346%, to 336.6 billion rupees from 261 billion rupees from July 1 to December 11, compared with the same period in the previous fiscal year, according to the central bank.

Government borrowing, a key factor in fueling inflation, is expected to increase to 600 billion rupees if the 2 billion rupees in daily borrowing from the central bank continues for the rest of the current fiscal year. That could increase interest payments on domestic and foreign borrowing to over 720 billion rupees from the 699 billion rupees allocated in the budget.

The proposed RGST would bring into the formal sector - and make taxable - a large range of economic activity at present without government documentation.

Powerful feudal lords have so far managed to keep agriculture income out of the tax net, according to a report in The News. Similarly, the powerful chambers of commerce and industries of Karachi, Lahore and Peshawar have won support from various political parties to campaign against the tax change.

The seven-tranche IMF program has kept the country's economy afloat since it was agreed in November 2008, even though disbursement of $3.4 billion has been held back due to the government's failure to observe performance benchmarks. The bailout was designed to shore up the country's foreign exchange reserves and avert a balance of payments crisis.

Though Pakistan's current account has shown a surplus for the last three months, it could easily deteriorate with rising oil prices.

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